The Hindu Business Line : Keep social purpose in mind

The Budget makes a brave attempt at estimating the revenues foregone under individual concessions. While this is a useful exercise, there is need for a much deeper analysis of alternative strategies before the Finance Minister can apply his scissors to the existing package of tax exemptions and concessions, says S. VENKITARAMANAN. Tax reformers are out to trim the hedges of the tax structure. Let their trimming not leave the field too bare. The tax collector may have to rue the fact that reforms have killed the goose that laid the golden eggs.

An important innovation in the Budget for 2006-07 was the inclusion of a list of tax expenditures under the Central Tax System. This is a statement of estimates of taxes foregone as a result of concessions and exemptions in various tax laws for export promotion, regional preference and gender justice, among other things.

The expression "tax expenditure" is intended to imply that the revenues foregone should have been more appropriately exhibited as expenditures under relevant Budget heads. Instead, they are expenditures "embedded in the revenue estimates". If they had been submitted as subsidies to the concerned individuals or corporates and appropriations asked for under Budget estimates of expenditure, the argument goes, they would have been more transparent.

The Budget attempts a brave exercise in estimating the revenues foregone under individual concessions, and presents a total estimate of Rs 1,58,661 crore for 2006-07 of taxes foregone. Considering that the Centre's total revenue from taxes is estimated to be just Rs 442,153 crore, the proportion of revenue foregone — if the estimates are right — is truly large.

"Tax expenditures" are typically difficult to estimate. If a particular tax exemption is given to encourage a certain activity, the revenue figure is calculated by estimating what the taxes would have garnered from the activity if the tax exemption was not available.

There is the obvious problem that, had the tax exemptions not been there, the level of related economic activity might have been much lower, and thus the calculation of revenues at pre-tax preference rates on a larger tax base may be flawed.

It must be conceded that the estimates of tax expenditures laid out in the Budget exhibit separately export-related input taxes to the extent of nearly Rs 35,000 crore. Excluding export-related input taxes, the tax expenditures amount to about Rs 1,23,000 crore. Export-related input tax rebates are based on the argument that an exporter cannot "export" local taxes.

The case for rebate of Customs and excise duties on exporter's inputs is not contested, even by the purists, although they point out various procedural bottlenecks in implementing these exemptions. In the reformers' world, these tax exemptions are not entirely unwelcome.

The broad break-up of tax expenditures in BE 2006-07 is shown in Table 1. Let us look at some of these expenditures to find out whether, and to what extent, they are justified or not. The broad break-up is given in Table 2.

A brief discussion of these figures serves to bring to light the cost-effectiveness of the tax expenditures in achieving their goals. To mention only one instance, software units have received an exemption amounting to Rs 7,080 crore, and the export earnings generated are in billions of dollars. Surely, this has been a most cost-effective expenditure, especially considering the large further untapped potential.

The amount of tax expenditure related to Special Economic Zones is relatively small, at Rs 1,340 crore. Now that the Government has decided on going the SEZ route a la the Chinese model, we should be imaginative in dealing with tax expenditures related to SEZs. Considering the benefits, including attracting fresh FDI, the tax expenditure outlay seems relatively modest.

Turning to infrastructure, the tax expenditure of Rs 5,800 crore or so is also well worth the while considering that Government places high priority on the development of infrastructure. Accelerated depreciation, which accounts for Rs 77,077 crore, is justified as an incentive for investment and makes India cost-competitive in relation to global peers. It is not too well-known that in respect of certain industries, the US allows for full expensing out of investments in a short period.

The purpose of the Finance Minister, Mr P. Chidambaram's presentation of the list of exemptions must obviously have been to put a brake on further requests for exemptions. Like all Finance Ministers, he would also prefer a flat tax — a uniform tax rate with few exemptions. This makes for much better administration and gives little scope for litigation and classification disputes. Even if the same purpose were served by direct subsidies, there would be much scope for abuse as targeting can be a complex task. Can we imagine subsidies of the order of Rs 158,000 crore administered by any department which does not have the knowledge of the business sector, such as the Revenue Department?

The advantage of "tax expenditures", as distinct from direct subsidies, is that the administration is quite familiar with the nature of the business and relates it to the quantum of tax payable. A direct payment of subsidies of this order will involve a large army of Government babus and inspectors. The tax expenditure on small savings instruments is around Rs 6,568 crore. Considering the sum collected under small savings, of nearly Rs 90,000 crore, this is a small proportion, especially when we consider the cumulative total of loans under small savings. To give it as a direct subsidy would be difficult and not worthwhile. It is important that the debate on tax concessions is carried on, keeping a sense of proportion about the size of relative cost benefits to the tax-payer and the overall social advantage garnered.

There is no question but that the tax concessions in respect of export promotion units, especially software, have been more than fully justified by experience. So, too, the volume of R&D effort, which is relatively small at present, cannot brook any elimination of related tax concession.

Overall, the tax concessions may need review, but do not seem to be in such a state that calls for radical change. The tax expenditure structure has served our social purpose well and should be amended, if at all, judiciously.

Tax reformers are out to trim the hedges of our tax structure. Let their trimming not leave the field too bare. The tax collector may have to rue the fact that reforms have killed the goose that laid the golden eggs.

While it is good that the Finance Minister has produced a statement that shows how large the tax concessions are, there is need for a much deeper analysis of alternative strategies before he can apply his scissors to the existing package of tax exemptions and concessions, which have played a useful role in creating an incentive structure for investments, exports, R&D, regional dispersal, and, above all, savings.